A 3% return? It may be all you can expect

By Matthew Heimer

Most retirement planning exercises ask the saver to estimate an annual rate of return for their nest-egg investments. When the markets were soaring in the 1990s, some investors were blithely assuming 10% annual returns; in these chastened, post-crash days, many investors make more conservative assumptions of 5% or 6%. But in an article this week, New York Times Wealth Matters columnist Paul Sullivan makes the case that for some investors, the real return going forward – after inflation, taxes and management fees—is likely to be more like 3%.

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Taxes, inflation and fees each take a slice.

It sounds grim, but such a return may be closer to normal than it seems at first glance. Sullivan is making a bigger point about how rare it is for financial advisers to be fully, exhaustively transparent about investment expectations and the costs of money management (a topic that Encore’s Glenn Ruffenach has also written about this week). For his case study, Sullivan speaks with planners at Evercore Wealth Management, a firm that manages $4.7 billion, mostly for clients with multiple millions of dollars to invest. Sullivan says Evercore makes a point of disclosing all of its projections about taxes, inflation and investment fees to potential client, including the expenses of the mutual funds in which the firm invests clients’ money –and then reporting what a client’s gains would be, net of all those costs. (“We don’t win every client we pitch,” says one of the planners, in what has to be a massive understatement.)

Sullivan and the planners walk through what a 40-year-old client who came to the firm with a $10 million portfolio could expect to earn. Sullivan chooses a “balanced portfolio” that’s projected to earn 7% a year over the next decade. But “taxes reduced the solid 7% return to 5%…factoring in long- and short-term capital gains at the highest federal rates,” Sullivan explains. “Inflation of 2% knocked it down to 3%.” And even that original 7% return was net of management costs, Sullivan explains: “The fictional me paid 1.23% of the portfolio, or $122,730, in annual fees.” His takeaway: In any meeting with a would-be financial adviser, “all investors should be focused on the real return and forget about that dazzling headline number.”

(Now might be the time to point out that a 3% return on $10 million nest egg is still a cool $300,000 a year, an amount at which I personally would not sneeze.)

About Encore

Encore looks at the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities, needs and priorities of people saving for and living in retirement. Our lead blogger is editor Matthew Heimer, and frequent contributors include editor Amy Hoak, writer Catey Hill, and MarketWatch columnists Elizabeth O’Brien, Robert Powell and Andrea Coombes. Encore also features regular commentary from The Wall Street Journal retirement columnists Glenn Ruffenach and Anne Tergesen and the Director of the Center for Retirement Research at Boston College, Alicia H. Munnell.